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Printed in the United States of America

Print Number: 01 Print Year: 2017

Mike W Peng is the

Jindal Chair of Global Business Strategy at the Jindal School of Mana­

gement, University of Texas at Dallas He

is also a National Sci­

ence Foundation (NSF) CAREER Award win­

ner and a Fellow of the Academy of Interna­

tional Business (AIB)

At UT Dallas, he has been the number­one contributor to the list of 50 top

journals tracked by Financial Times, which has consis­

tently ranked UT Dallas as a top 20 school in research

worldwide

Professor Peng holds a bachelor’s degree from

Winona State University, Minnesota, and a PhD from

the University of Washington, Seattle He had previously

served on the faculty at the Ohio State University, Uni­

versity of Hawaii, and Chinese University of Hong Kong

He has taught in five states in the United States (Hawaii,

Ohio, Tennessee, Texas, and Washington), as well as in

China, Hong Kong, and Vietnam He has also held visit­

ing or courtesy appointments in Australia, Britain,

China, Denmark, Hong Kong, and the United States,

and lectured around the world

Professor Peng is one of the most­prolific and most­

influential scholars in international business (IB) Both

the United Nations and the World Bank have cited his

work During the decade 1996–2006, he was the top

seven contributor to IB’s number­one premier outlet:

Journal of International Business Studies In 2015, he

received the Journal of International Business

Stud-ies Decade Award A Journal of Management article

found him to be among the top 65 most widely cited

management scholars, and an Academy of Management

Perspectives study reported that he is the fourth­most­

influential management scholar among professors who

have obtained their PhD since 1991 Overall, Professor

Peng has published more than 140 articles in leading

journals and five books Since the launch of GLOBAL,

he has not only published in top IB journals, such

as the Academy of Management Journal, Journal of

International Business Studies, Journal of World ness, and Strategic Management Journal, but also in leading outlets in entrepreneurship (Entrepreneurship Theory and Practice), ethics (Journal of Business Ethics), human resources (International Journal of Human Resource Management), and engineering management (IEEE Transactions on Engineering Management).

Busi-Used in more than 30 countries, Professor Peng’s best­

selling textbooks, Global Business, Global Strategy, and GLOBAL, are global market leaders that have been trans­

lated into Chinese, Portuguese, and Spanish A European adaptation (with Klaus Meyer) and an Indian adaptation (with Deepak Srivastava) have been successfully launched.Truly global in scope, Professor Peng’s research has investigated firm strategies in Africa, Asia Pacific, Europe, and North America He is best known for his development of the institution­based view of strategy and his insights about the rise of emerging economies such as China in global business With more than 29,000 Google citations and an H­index of 69, he is

listed among The World’s Most Influential Scientific Minds (compiled by Thomson Reuters based on cita­

tions covering 21 fields)—in the field of eco nomics and business, he is one of the only 70 world­class scholars

listed and the only IB textbook author listed

Professor Peng is active in leadership positions He

has served on the editorial boards of the AMJ, AMP, AMR, JIBS, JMS, JWB, and SMJ; and guest­edited a special issue for the JMS At AIB, he co­chaired the AIB/JIBS Frontiers Conference in San Diego (2006), guest­edited a JIBS special issue (2010), chaired the

Emerging and Transition Economies track for the Nagoya conference (2011), and chaired the Richard Farmer Best Dissertation Award Committee for the Washington con­ference (2012) At the Strategic Management Society (SMS), he was elected to be the Global Strategy Interest Group Chair (2008) He also co­chaired the SMS Special Conferences in Shanghai (2007) and in Sydney (2014)

He served one term as Editor­in­Chief of the Asia Pacific Journal of Management He managed the successful bid

to enter the Social Sciences Citation Index (SSCI), which

reported APJM’s first citation impact to be 3.4 and rated

it as the top 18 among 140 management journals (by citation impact factor) for 2010 In recognition of his

significant contributions, APJM has named its best paper

ABOUT THE AUTHOR

Professor Peng is also an active consultant, trainer,

and keynote speaker He has provided on­the­job train­

ing to more than 400 professors He has consulted and

been a keynote speaker for multinational enterprises

(such as AstraZeneca, Berlitz, Mass Transit Railway

Hong Kong, Nationwide, SAFRAN, and Texas Instru­

ments), nonprofit organizations (such as World Affairs

Council of Dallas­Fort Worth), educational and funding

organizations (such as Canada Research Chair, Harvard

Kennedy School of Government, US National Science

Foundation, and Natural Science Foundation of China),

and national and international organizations (such as the

UK Government Office for Science, US­China Business

Council, US Navy, and The World Bank)

Small Business Administration Best Paper Award, a (lifetime) Distinguished Scholar Award from the South­western Academy of Management, a (lifetime) Scholarly Contribution Award from the International Association for Chinese Management Research (IACMR), and a Best Paper Award named after him He has been quoted by

The Economist, Newsweek, Dallas Morning News, Texas CEO Magazine, Smart Business Dallas, Atlanta Journal- Constitution, The Exporter Magazine, The World Jour- nal, Business Times (Singapore), CEO­CIO (Beijing), Sing Tao Daily (Vancouver), and Brasil Econômico (São

Paulo), as well as on the Voice of America

2 Understanding Politics, Laws, & Economics 20

3 Emphasizing Cultures, Ethics, & Norms 36

4 Leveraging Resources & Capabilities 52

Part 2: Acquiring Tools 66

5 Trading Internationally 66

6 Investing Abroad Directly 86

7 Dealing with Foreign Exchange 102

8 Capitalizing on Global & Regional Integration 120

Part 3: Managing around the World 138

9 Growing & Internationalizing the Entrepreneurial Firm 138

10 Entering Foreign Markets 152

11 Making Alliances & Acquisitions Work 168

12 Strategizing, Structuring, & Learning around the World 184

14 Competing in Marketing & Supply Chain Management 220

15 Managing Corporate Social Responsibility Globally 234

Endnotes 248

Index 252

Tear-out Cards PengAtlas Maps

2-5 LEGAL SYSTEMS 28

2-5a Civil Law, Common Law, and Theocratic Law 28

2-6 PROPERTY RIGHTS AND INTELLECTUAL PROPERTY RIGHTS 29

2-6a Property Rights 29 2-6b Intellectual Property Rights 29

2-7 ECONOMIC SYSTEMS 30

2-7a Market, Command, and Mixed Economies 30 2-7b What Drives Economic Development? 31

2-8 MANAGEMENT SAVVY 32

Closing Case: Carlsberg Confronts Political Risk in Russia 33

3 Emphasizing Cultures, Ethics,

& Norms 36

Opening Case: Partying in Saudi Arabia and Xinjiang, China 37

3-1 WHERE DO INFORMAL INSTITUTIONS COME FROM? 37 3-2 CULTURE 38

3-2a Definition of Culture 38 3-2b Language 38 3-2c Religion 40

3-3 CLASSIFYING CULTURAL DIFFERENCES 40

3-3a The Context Approach 40 3-3b The Cluster Approach 41 3-3c The Dimension Approach 42

3-4 CULTURE AND GLOBAL BUSINESS 45 3-5 ETHICS 46

3-5a Definition and Impact of Ethics 46 3-5b Managing Ethics Overseas 46

3-6 ETHICS AND CORRUPTION 47 3-7 NORMS AND ETHICAL CHALLENGES 48 3-8 MANAGEMENT SAVVY 49

Closing Case: Monetizing the Maasai Tribal Name 50

1 Globalizing Business 2

Opening Case: Shanghai Disneyland 3

1-1 WHAT IS GLOBAL BUSINESS? 4

1-2 WHY STUDY GLOBAL BUSINESS? 6

1-3 A UNIFIED FRAMEWORK 7

1-3a One Fundamental Question 7

1-3b First Core Perspective: An Institution-Based View 9

1-3c Second Core Perspective: A Resource-Based View 10

1-3d A Consistent Theme 10

1-4 WHAT IS GLOBALIZATION? 10

1-4a Three Views on Globalization 11

1-4b The Pendulum View on Globalization 12

1-4c Semiglobalization 13

1-5 A GLANCE AT THE GLOBAL ECONOMY 15

1-6 ORGANIZATION OF THE BOOK 16

Closing Case: Two Scenarios of the Global Economy in 2050 16

2 Understanding Politics, Laws,

& Economics 20

Opening Case: The Newest Transition Economy 21

2-1 UNDERSTANDING INSTITUTIONS 22

CONTENTS

5-4 MANAGEMENT SAVVY 83

Closing Case: The China Trade Debate 84

6 Investing Abroad Directly 86

Opening Case: Nordic Multinationals 87

6-1 UNDERSTANDING THE FDI VOCABULARY 87

6-1a The Key Word Is Direct 88 6-1b Horizontal and Vertical FDI 88 6-1c FDI Flow and Stock 88 6-1d MNE versus Non-MNE 89

6-2 WHY DO FIRMS BECOME MNEs BY ENGAGING

IN FDI? 89 6-3 OWNERSHIP ADVANTAGES 91

6-3a The Benefits of Direct Ownership 91 6-3b FDI versus Licensing 91

6-7 MANAGEMENT SAVVY 99

Closing Case: FDI in the Indian Retail Industry 100

7 Dealing with Foreign Exchange 102

Opening Case: The All-Mighty Dollar 103

7-1 WHAT DETERMINES FOREIGN EXCHANGE RATES? 104

7-1a Basic Supply and Demand 104 7-1b Relative Price Differences and Purchasing Power Parity 105 7-1c Interest Rates and Money Supply 106

7-1d Productivity and Balance of Payments 107 7-1e Exchange Rate Policies 108

7-1f Investor Psychology 109

4 Leveraging Resources

& Capabilities 52

Opening Case: LEGO’s Secrets 53

4-1 UNDERSTANDING RESOURCES AND CAPABILITIES 54

4-2 RESOURCES, CAPABILITIES, AND THE VALUE CHAIN 55

4-3 WHEN AND WHEN NOT TO OUTSOURCE 56

4-4 FROM SWOT TO VRIO 59

4-4a The Question of Value 59

4-4b The Question of Rarity 60

4-4c The Question of Imitability 60

4-4d The Question of Organization 61

4-5 MANAGEMENT SAVVY 62

Closing Case: The Rise of Alibaba 63

Part 2

5 Trading Internationally 66

Opening Case: Why Are US Exports So Competitive? 67

5-1 WHY DO NATIONS TRADE? 68

5-2 THEORIES OF INTERNATIONAL TRADE 70

5-2a Mercantilism 70

5-2b Absolute Advantage 70

5-2c Comparative Advantage 71

5-2d Product Life Cycle 73

5-2e Strategic Trade 74

5-2f National Competitive Advantage of Industries 75

5-2g Evaluating Theories of International Trade 76

Acquiring Tools

7-2a The Gold Standard (1870–1914) 109

7-2b The Bretton Woods System (1944–1973) 110

7-2c The Post–Bretton Woods System (1973–Present) 110

7-2d The International Monetary Fund 111

7-3 STRATEGIC RESPONSES 111

7-3a Strategies for Financial Companies 113

7-3b Strategies for Nonfinancial Companies 115

7-4 MANAGEMENT SAVVY 116

Closing Case: Bellini Do Brasil’s Foreign Exchange Challenges 117

8 Capitalizing on Global

& Regional Integration 120

Opening Case: Brexit 121

8-1 INTEGRATING THE GLOBAL ECONOMY 122

8-1a Political Benefits for Global Economic Integration 122

8-1b Economic Benefits for Global Economic Integration 123

8-2 ORGANIZING WORLD TRADE 124

8-2a General Agreement on Tariffs and Trade: 1948–1994 124

8-2b World Trade Organization: 1995–Present 124

8-2c Trade Dispute Settlement 125

8-2d The Doha Round: “The Doha Development Agenda” 125

8-3 INTEGRATING REGIONAL ECONOMIES 126

8-3a The Pros and Cons of Regional Economic Integration 126

8-3b Types of Regional Economic Integration 127

8-4 REGIONAL ECONOMIC INTEGRATION

IN EUROPE 128

8-4a Origin and Evolution 128

8-4b The EU Today 128

8-4c The EU’s Challenges 129

8-5 REGIONAL ECONOMIC INTEGRATION IN THE

AMERICAS 131

8-5a North America: North American Free Trade Agreement

(NAFTA) 131

8-5b South America: Andean Community, Mercosur, USAN/

UNASUR, and CAFTA 132

8-6 REGIONAL ECONOMIC INTEGRATION IN THE ASIA

PACIFIC 133

8-6a Australia–New Zealand Closer Economic Relations Trade

Agreement (ANZCERTA or CER) 133

8-6b Association of Southeast Asian Nations (ASEAN) 133

8-6c Asia–Pacific Economic Cooperation (APEC) and Trans–

Pacific Partnership (TPP) 133

8-7 MANAGEMENT SAVVY 135

Closing Case: What If NAFTA Goes Away? 136

9 Growing & Internationalizing the Entrepreneurial Firm 138

Opening Case: Sriracha Spices Up American Food 139

9-1 ENTREPRENEURSHIP AND ENTREPRENEURIAL FIRMS 140 9-2 INSTITUTIONS, RESOURCES, AND

9-4 INTERNATIONALIZING THE ENTREPRENEURIAL FIRM 145

9-4a Transaction Costs and Entrepreneurial Opportunities 145 9-4b International Strategies for Entering Foreign Markets 146 9-4c International Strategies for Staying in Domestic Markets 148

9-5 MANAGEMENT SAVVY 148

Closing Case: Boom in Busts: Good or Bad? 150

10 Entering Foreign Markets 152

Opening Case: Coca-Cola Pours into Africa 153

10-1 OVERCOMING THE LIABILITY OF FOREIGNNESS 154 10-2 WHERE TO ENTER? 155

10-2a Location-Specific Advantages and Strategic Goals 155

10-3 WHEN TO ENTER? 159

10-4 HOW TO ENTER? 160

10-4a Scale of Entry: Commitment and Experience 160

10-4b Modes of Entry: The First Step on Equity versus Nonequity

& Acquisitions Work 168

Opening Case: Etihad Airways’ Alliance Network 169

11-1 DEFINING ALLIANCES AND ACQUISITIONS 169

11-2 HOW INSTITUTIONS AND RESOURCES AFFECT ALLIANCES

AND ACQUISITIONS 170

11-2a Institutions, Alliances, and Acquisitions 171

11-2b Resources and Alliances 172

11-2c Resources and Acquisitions 174

Opening Case: Launching the McWrap 185

12-1 MULTINATIONAL STRATEGIES AND STRUCTURES 186

12-1a Pressures for Cost Reduction and Local

Responsiveness 186

12-1b Four Strategic Choices 187

12-1c Four Organizational Structures 189

12-1d The Reciprocal Relationship between Multinational

Strategy and Structure 191

12-2 HOW INSTITUTIONS AND RESOURCES AFFECT

MULTINATIONAL STRATEGY, STRUCTURE, AND

12-3c Globalizing Research and Development 197

12-4 MANAGEMENT SAVVY 198

Closing Case: Moving Headquarters Overseas 198

13 Managing Human Resources Globally 202

Opening Case: IKEA Manages Human Resources in the United States 203

13-2 TRAINING AND DEVELOPMENT 208

13-2a Training for Expatriates 208 13-2b Development for Returning Expatriates (Repatriates) 209 13-2c Training and Development for Host-Country Nationals 210

13-3 COMPENSATION AND PERFORMANCE APPRAISAL 210

13-3a Compensation for Expatriates 210 13-3b Compensation for Host-Country Nationals 211 13-3c Performance Appraisal 212

Opening Case: Marketing Aflac in the United States and Japan 221

14-1 THREE OF THE FOUR Ps IN MARKETING 222

14-1a Product 222 14-1b Price 224 14-1c Promotion 224

14-4 HOW INSTITUTIONS AND RESOURCES

AFFECT MARKETING AND SUPPLY CHAIN

MANAGEMENT 229

14-4a Institutions, Marketing, and Supply Chain

Management 229 14-4b Resources, Marketing, and Supply Chain

Management 230

14-5 MANAGEMENT SAVVY 231

Closing Case: Online Shop Number One 232

15 Managing Corporate Social

Responsibility Globally 234

Opening Case: Foxconn 235

15-1 A STAKEHOLDER VIEW OF THE FIRM 236

15-1a A Big Picture Perspective 236

15-1b Primary and Secondary Stakeholder Groups 237

Access GLOBAL4 ONLINE at www.cengagebrain.com

Interactive Resources!

After you finish this chapter, go to

After studying this chapter, you will be able to . . .

1-1 Explain the concepts of international

business and global business.

1-2 Give three reasons why it is important to

study global business.

1-3 Articulate the fundamental question that

the study of global business seeks to answer

and the two perspectives from which to

Opening Case: Shanghai Disneyland

On June 16, 2016, the world’s

biggest Disneyland opened

in Shanghai with a great deal of fanfare It features a supersize castle that is 200-feet tall In comparison, the height for similar castles in Anaheim, California, and Orlando, Florida, is 77 feet and 180 feet, respectively Approximately 80% of the Shanghai rides, such as the Tron Lightcycle Roller Coaster, are unique Chinese elements are extensively found The flagship restaurant, the Wandering Moon Teahouse, has sections representing different regions of China

Some old staples found in other Disney parks, such as Main Street USA, Jungle Cruise, and Space Mountain, have been banished—in fear of criticisms for cultural imperialism “Authentically Disney and distinctly Chinese” is an interesting tagline coined by Robert Iger, chairman and CEO of The Walt Disney Company (“Disney” hereafter)

More than 330 million people live within a three-hour drive or train ride Disney is eager to turn them into lifelong customers not only for the $5.5 billion theme park, but also for movies, games, toys, clothes, books, TV programs, cruises, and resorts

Mickey’s journey to the Middle Kingdom has been a tortuous one The two-decade courtship started in the late 1990s, when Jiang Zemin was president of China and Michael Eisner chairman and CEO of Disney At that time, Disney was starting to have some success in China, with its cartoon series aired on Sunday evenings by major TV stations Then Disney launched a movie

about the exiled Tibetan spiritual leader the Dalai Lama, Kundun,

which attracted the wrath of the Chinese government “All of our business in China stopped overnight,” Eisner recalled Out of desperation, Disney hired as a consultant former Secretary of State Henry Kissinger, who spearheaded American efforts to establish diplomatic ties with China in the 1970s and was regarded as

a trustworthy friend by the Chinese The Chinese government only agreed to reopen China after intense lobbying by Kissinger

and humiliating apologies by Eisner, who admitted Kundun was

“a stupid mistake” in meetings with Chinese officials Financially,

Kundun was indeed a stupid mistake It burned through a

$30 million budget to reap only $5 million box office receipts

Eisner then introduced Iger, Disney’s international president at that time, to be in charge of negotiations for a theme park The negotiations were slow and painful Looking back, Iger, who succeeded Eisner as CEO in 2005 and as

chairman in 2012, recalled in a New York Times interview that he

had “engaged with three [Chinese] presidents, a few premiers,

a number of vice premiers, a number of [Communist] Party secretaries, and five or six mayors of Shanghai.”

By 2009, the Chinese government finally gave its blessing,

but only after Disney agreed to be a minority partner Disney took

a 43% stake in the Shanghai Disney Resort Shanghai Disney Resort would not only include the flagship Shanghai Disneyland, but also two additional theme parks, two themed hotels,

shopping malls, and entertainment facilities—when completed

it would be three times the size of Hong Kong Disneyland

Disney’s joint venture (JV) partner, the state-owned Shanghai Shendi Group controlled by the Shanghai government, owned

a 57% stake In the management company that actually ran the property, Disney gave up a 30% piece In comparison, the Hong Kong government gave a 48% share to Disney for the JV that owned Hong Kong Disneyland, and the government itself took 52% Disney gave up no management control in Hong Kong

Why was Disney so eager to go to China? Although China’s pull in terms of market size and potential is obvious, Disney is also pushed by its lackluster performance in other areas such

as cable, movies, and some of its other theme parks In April

2011, Shanghai Disneyland broke ground, with Iger and Chinese officials scooping up loose dirt, Mickey and Minnie Mouse frolicking in Chinese costumes, and a children’s choir singing

When You Wish Upon a Star—in Mandarin Despite such hoopla,

there was no guarantee that Disney’s high-profile entry would be profitable Exhibit A: Disneyland Paris, which opened in 1992, is still struggling to reach profitability

For Shanghai Disneyland, the attention to detail was meticulous In addition to the tremendous efforts to showcase local responsiveness, with 80% of the rides being uniquely tailored to local interests, Iger also pre-tasted the food (such as Donald Duck-shaped waffles) and decided which characters would appear in the parade When first unveiled in March

2016, Shanghai Disneyland’s website registered 5 million hits within 30 minutes The first two weeks of tickets sold out in hours

Yet as Shanghai Disneyland celebrated its first Chinese New Year in January 2017, disappointing news came In its first six months ending on December 31, 2016, 5.6 million guests

came Although impressive, these numbers fell far short of rosy

initial projections of an estimated 15 million visitors for the first year If attendance continued at its current pace, then the first full-year result would barely reach over 10 million In the Disney universe, 10 million visitors in the first year would not be too bad, as Hong Kong only attracted seven million in 2015—its 11th year In comparison, in 2015, Tokyo reported 17 million; Anaheim 18 million; and Orlando 19 million Although these sister parks are a lot more established, Shanghai Disneyland clearly has a long way to go As the Magic Kingdom embarks

on its residence in the Middle Kingdom, one thing is clear: this China business is not going to be Mickey Mousy

Sources: “Disney gets a second chance in China,” Bloomberg Businessweek, 18 April 2011: 21–22; “Middle Kingdom v Magic Kingdom,” Guardian, 15 June 2016: www.theguardian com; “How China won the keys to Disney’s Magic Kingdom,” New York Times, 14 June 2016: www.nytimes.com; M W Peng, “Mickey goes to Shanghai,” in Global Business,

4th ed (Boston: Cengage, 2017) 339–340; “Shanghai Disneyland welcomes 5.6 million

visitors in first six months, is kind of a disappointment,” Shanghaiist, 17 January 2017:

www.shanghaiist.com.

Hglobe? How can competitors such as Europa Park,

Happy Valley, Legoland, Lotte World, Sea World, Six Flags,

Tivoli, and Universal Studios fight back? What determines

the success and failure of these firms—and numerous

others—around the world? This book will address these

and other important questions on global business

Ask yourself: Which country made the shirt you

are wearing? Which country made the mobile device

you have? Why are Airbus jets, Apple iPhones, Corona

beer, Microsoft software, Starbucks coffee, and Toyota

cars found in many places that you travel to? Can you

join the men and women who are the real movers and

shakers driving these successful firms? What are their

secrets? Of course, there are numerous other firms

around the world that are not so successful How can

you learn the lessons from these unsuccessful firms and

avoid the mistakes made by their managers? Tackling

these interesting questions, GLOBAL 4 will be with

you as you embark on your global business studies and

launch your career Enjoy the ride!

1-1 WHAT IS GLOBAL BUSINESS?

Traditionally, international business (IB) is defined as

a business (firm) that engages in international (cross-

border) economic activities It can also refer to the

ac-tion of doing business abroad A previous generaac-tion of

IB textbooks almost always takes the foreign entrant’s

perspective Consequently, such books deal with

is-sues such as how to enter foreign markets and how to

select alliance partners The most frequently discussed

foreign entrant is the multinational enterprise (MNE),

defined as a firm that

and their cross-border activities are important But they cover only one side of IB—the foreign side Students educated by these books often come away with the im-pression that the other side of IB—namely, domestic firms—does not exist But domestic firms obviously do not just sit around in the face of foreign entrants such as MNEs They actively compete and/or collaborate with foreign entrants.2 In other words, focusing on the foreign entrant side captures only one side of the coin at best

There are two key words in IB: international (I) and

business (B) However, previous textbooks all focus on the international aspect (the foreign entrant) to the ex-tent that the business part (which also includes domestic business) almost disappears This is unfortunate because

IB is fundamentally about B in addition to being I To put it differently, the IB course in the undergraduate and MBA curricula at numerous business schools is probably

the only course with the word “business” in the course

title All other courses you take are labeled ment, marketing, finance, and so on, representing one functional area but not the overall picture of business Does it matter? Of course! It means that your IB course

manage-is an integrative course that has the potential to provide

you with an overall business perspective grounded in a global environment (as opposed to a relatively narrow functional view) Consequently, it makes sense that your textbook should give you both the I and B parts, not just the I part

is defined in this book as business around the globe—

thus the title of this book: GLOBAL For the B part, the activities include both international (cross-border)

activities covered by traditional IB books and domestic (non-IB) business activities Such deliberate blurring

of the traditional boundaries separating international and domestic business is increasingly important today,

because many previously

na-tional (domestic) kets are now

international business (IB)

(1) A business (firm) that engages

in international (cross-border)

economic activities or (2) the action

of doing business abroad.

multinational enterprise

(MNE) A firm that engages in

foreign direct investment and

operates in multiple countries.

foreign direct investment

(FDI) Investment in, controlling,

and managing value-added

activities in other countries.

global business Business around

the globe.

4

an adjustment to reflect the differences in cost of living

Of many emerging economies, Brazil, Russia, India,

more attention With South Africa, BRIC becomes

world’s population, cover a quarter of the world’s land area, and contribute more than 25% of global GDP (on

a PPP basis) In addition to BRICS, other interesting terms include BRICM (BRIC + Mexico), BRICET (BRIC + Eastern Europe and Turkey), and Next Eleven (N-11—consisting of Bangladesh, Egypt, Indonesia, Iran, Korea, Mexico, Nigeria, Pakistan, the Philippines, Turkey, and Vietnam)

Overall, the Great Transformation of the global economy is embodied by the tremendous shift

in economic weight and engines of growth toward emerging economies in general and BRIC(S) in particular Led by BRIC(S), emerging economies accomplished “the biggest economic transformation

In China, per capita income doubled in about ten years, an achievement that took Britain 150 years and the United States 50 years as they industrialized Throughout emerging economies, China is not alone While groupings such as BRIC(S) and N-11 are al-ways arbitrary, they serve a useful purpose—namely, highligh ting their eco-

nomic and demographic scale and trajectory that enable them to chal-lenge developed econo-mies in terms of weight and influence in the global economy

Of course, the Great Transformation is not a linear story of endless and uniform high-speed growth Most emerg-ing economies have experienced some significant slow down recently.5 It

is possible that they may not be able to repeat their extraordi-nary growth sprint

college business textbook

publishers was primarily on

a nation-by-nation basis The

Big Three—Cengage

Learn-ing (our publisher), Prentice Hall, and McGraw-Hill—

primarily competed in the United States A different

set of publishers competed in other countries As a

result, textbooks studied by British students would

be authored by British professors and published by

British publishers; textbooks studied by Brazilian

stu-dents would be authored by Brazilian professors and

published by Brazilian publishers; and so on Now

Cengage (under British and Canadian ownership),

Pearson Prentice Hall (under British ownership),

and McGraw-Hill (under US ownership) have

sig-nificantly globalized their competition, thanks to

rising demand for high-quality business textbooks in

English Around the globe, they compete against each

other in many markets, publishing in multiple

lan-guages For instance, GLOBAL and its sister books—

Global Business, Global Strategy, and International

Business (a European adaptation)—are published

by different subsidiaries in Chinese, Spanish, and

Portuguese in addition to English, reaching

custom-ers in over 30 countries Despite such worldwide

spread of competition, in each market—down to each

school—textbook publishers have to compete locally

In other words, no professor teaches globally, and

all students study locally This means that GLOBAL

has to win adoption for every class every semester

Overall, it becomes difficult to tell in this

competi-tion what is internacompeti-tional and what is domestic Thus,

“global” is a better word to capture the essence of this

competition

GLOBAL also differs from other IB books because

most focus on competition in developed economies

Here, by contrast, we devote extensive space to

term “developing countries” since the 1990s

(see PengAtlas Map 1) How important are

emerging economies? Collectively, they

command 48% of world trade, attract

60% of FDI inflows, and generate 40%

FDI outflows Overall, emerging

econ-omies contribute approximately 50%

than a third of a much smaller world GDP

emerging economy (emerging market) A developing country.

gross domestic product (GDP)

The sum of value added by resident firms, households, and governments operating in an economy.

purchasing power parity (PPP)

A conversion that determines the equivalent amount of goods and services different currencies can purchase This conversion is usually used to capture the differences in cost of living in different countries.

BRIC An acronym for the emerging economies of Brazil, Russia, India, and China.

BRICS An acronym for the emerging economies of Brazil, Russia, India, China, and South Africa.

ISTOCK.COM/HENRIK5000 NERTHUZ/SHUTTERSTOCK.COM

during the decade between 1998 (the Asian economic

cri-sis) and 2008 (the global financial cricri-sis) For example, in

2007, Brazil accomplished an annual economic growth of

6%, Russia 8%, India 10%, and China 14% In 2017, they

would be very lucky if they could achieve half of these

envi-able growth rates However, it seems that emerging

econo-mies as a group are destined to grow both their absolute

GDP and their percentage of world GDP relative to

de-veloped economies The debate centers on how much and

how fast (or how slow) they will grow in the future (see

Closing Case)

The global economy can be viewed as a pyramid

shown in Exhibit 1.1 The top consists of about one

bil-lion people with per capita annual income of $20,000 or

higher These are mostly people who live in the developed economies

of the Triad, which sists of North America, Western Europe, and Japan Another billion people making $2,000

con-to $20,000 a year form the second tier The vast majority of human-ity—about five billion

ditional IB books) focus on the top and second tiers and end up ignoring the BoP An increasing number of such low-income countries have shown increasingly more economic opportunities as income levels have risen.6 Today’s students—and tomorrow’s business leaders—will ignore these opportunities in BoP markets at their own peril This book will help ensure that you will not ignore these opportunities

1-2 WHY STUDY GLOBAL BUSINESS?

Global business (or IB) is one of the most exciting, challenging, and relevant subjects offered by business schools There are at least three compelling reasons why you should study it—and study hard (Exhibit 1.2) First, you don’t want to be a loser Mastering global business knowledge helps advance your employability and career

in an increasingly competitive global economy An rant individual is unlikely to emerge as a winner in global competition

igno-Second, expertise in global business is often

a prerequisite to join the top ranks of large firms, something many ambitious students aspire to It is now increasingly difficult, if not impossible, to find top managers at large firms who do not possess sig-nificant global competence Eventually you will need hands-on global experience, not merely knowledge acquired from this course However, in order to set yourself apart as an ideal candidate to be selected for

an executive position, you will need to demonstrate that you are interested in global business and have mastered such knowledge during your education This

is especially true if you are interested in gaining

short)—a manager who works abroad (see Chapter 13 for details)

Sources: C K Prahalad and S Hart, “The fortune at the bottom of the pyramid,”

School Publishing, 2005) 111 GNI refers to gross national income.

Per capita GDP/GNI

> $20,000 Approximately

1 billion people

Per capita GDP/GNI

$2,000–$20,000 Approximately 1 billion people

Per capita GDP/GNI < $2,000 Approximately 5 billion people

Triad Three regions of developed

economies (North America, Western

Europe, and Japan).

base of the pyramid (BoP) The

vast majority of humanity, about five

billion people, who make less than

$2,000 a year.

expatriate manager (expat)

A manager who works outside his

or her native country.

EXHIBIT 1.2 WHY STUDY GLOBAL BUSINESS?

PYRAMID

On the other hand, top-level jobs, especially those

held by expats, are both financially rewarding and

relatively secure Expats often command a

significant pay raise when working overseas In US

firms, their total compensation package can be

approxi-mately $300,000 to $400,000 (including benefits; not

all is take-home pay)

Even if you do not want to be a sought-after,

globe-trotting expat, we assume that you do not want to join

the ranks of the unemployed due to the impact of

glo-balization and technology (see Exhibit 1.3)

Lastly, even if you do not aspire to compete for the

top job at a large firm or work overseas, and even if you

work at a small firm or are self-employed, you may find

yourself dealing with foreign-owned suppliers and

buy-ers, competing with foreign-invested firms in your

home market, and perhaps even selling and investing

overseas Alternatively, you may find yourself working

for a foreign-owned firm, your domestic employer may

be acquired by a foreign player, or your unit may be

ordered to shut down for global consolidation Any of

these is a very likely scenario, because approximately

80 million people worldwide, including 18 million

Chinese, six million Americans, and one million

Bri-tish, are employed by foreign-owned firms In the

pri-vate sector, Taiwan-based Foxconn is the largest

employer in China, India-based Tata Group is the

EXHIBIT 1.3 THE IMPACT OF GLOBALIZATION

To avoid the fate humorously portrayed in Exhibit 1.3,

a good place to start is to study hard and do well in your

IB course Of course, don’t forget to put this course on

your résumé as a highlight of your education (In Focus has additional advice on what language and what fields

to study.)

1-3 A UNIFIED FRAMEWORK

Global business is a vast subject area It is one of the few courses that will make you appreciate why your university requires you to take a number of diverse courses in general education We draw on major social sciences such as economics, geography, history, psy-chology, political science, and sociology We also draw

on a number of business disciplines such as finance, marketing, and strategy The study of global business is thus very interdisciplinary.7 It is easy to lose sight of the forest while scrutinizing various trees or even branches The subject is not difficult, and most students find it to

be fun The number-one student complaint is about the overwhelming amount of information Truth be told,

this is also my number-one complaint as your author

You may have to read and learn this material, but I have

to bring it all together in a way that makes sense and in

a compact book that does not go on and on and on for

900 pages To make your learning more focused, more manageable, and hopefully more fun, in this book we develop a unified framework consisting of one funda-mental question and two core perspectives (shown in Exhibit 1.4)

1-3a One Fundamental Question8

What is it that we do in global business? Why is it so portant that practically all students in business schools around the world are either required or recommended

im-to take this course?

While there are certainly

a lot of questions to raise,

a relentless interest in what determines the

international premium A significant pay raise commanded by expatriates when working overseas.

What Language and What

Fields Should I Study?

On September 3, 2007, Markéta Straková of Tabor, the Czech

Republic, wrote to BusinessWeek columnists Jack Welch

and Suzy Welch:

I am thinking of studying Portuguese, but in your opinion, what language

should I learn to succeed in the world of business? And what fields of study

hold the most potential?

Jack Welch was the former chairman and CEO of General

Electric (GE), and Suzy Welch was the former editor of Harvard

Business Review They wrote back in the same issue of

BusinessWeek:

You’re on to something with Portuguese, since it will give you a leg up in

several markets with good potential, such as Brazil and some emerging

African nations Spanish is also a good choice, as it will allow you to

operate with more ease throughout Latin America, and, increasingly,

the United States But for our money—and if you can manage the much

higher order of commitment—Chinese is the language to learn China is

already an economic powerhouse It will only gain strength Anyone who

can do business there with the speed and intimacy that fluency affords will

earn a real competitive edge.

As for what to study—and if you want to be where the action is now

and for the next couple of decades—consider the industries focused

on alternative sources of energy Or learn everything you can about the confluence of three fields: biotechnology, information technology, and nanotechnology For the foreseeable future, the therapies, machines, devices, and other products and services that these fields bring to market will revolutionize society—and business.

That said, when it comes to picking an education field and ultimately a career, absolutely nothing beats pursuing the path that truly fascinates your brain, engages your energy, and touches your soul Whatever you do,

do what turns your crank Otherwise your job will always be just work, and how dreary is that?

Source: J Welch and S Welch, “Ideas: The Welch way,” BusinessWeek, 3 September

be successful domestically but fail miserably overseas Other firms successfully translate their strengths from their home markets to other countries If you were ex-pected to lead your firm’s efforts to enter a particular foreign market, wouldn’t you want to find out what drives the success and failure of other firms in that market?

Overall, the focus on firm performance around the globe defines the field of global business (or IB) more than anything else Numerous other questions all relate

in one way or another to this most fundamental question Therefore, all chapters in this book are centered on this fundamental question: What determines the success and failure of firms around the globe?

Institution-Based View:

Formal and informal

rules of the game

Fundamental Question:

What determines the success and failure of firms around the globe?

Resource-Based View:

Firm-specific

resources and capabilities

EXHIBIT 1.4 A UNIFIED FRAMEWORK FOR

GLOBAL BUSINESS

1-3b First Core Perspective:

An Institution-Based View9

failure of firms are enabled and constrained by

institu-tions By institutions, we mean the rules of the game

Doing business around the globe requires intimate

knowl-edge about both formal rules (such as laws) and informal

rules (such as values) that govern competition in various

countries as an institutional framework Firms that do

not do their homework and thus remain ignorant of the

rules of the game in a certain country are not likely to

emerge as winners

Formal institutions include laws, regulations, and

rules For example, Hong Kong’s laws are well known

for treating all comers, whether from neighboring

main-land China (whose firms are still technically regarded as

“nondomestic”) or far-away Chile, the same as they treat

indigenous Hong Kong firms Such equal treatment

enhances the potential odds for foreign firms’ success

It is thus not surprising that Hong Kong attracts a lot

of outside firms Other rules of the game discriminate

against foreign firms and undermine their chances for

success India’s recent attraction as a site for FDI was

only possible after its regulations changed from tational to accommodating Prior to 1991, India’s rules severely discriminated against foreign firms For ex-ample, in the 1970s, the Indian government demanded that Coca-Cola either hand over the recipe for its secret syrup, which it does not even share with the US govern-ment, or get out of India Painfully, Coca-Cola chose to leave India Its return to India since the 1990s speaks volumes about how much the rules of the game have changed in India

confron-Informal institutions include cultures, ethics, and norms They also play an important part in shaping the success and failure of

firms around the globe (see Opening Case) For example, individualistic societies, particularly the English-speaking coun-tries such as Australia, Britain, and the United States, tend to have a relatively higher level of entrepreneurship as re-flected in the high number

institution-based view A leading perspective in global business that suggests that firm performance is,

at least in part, determined by the institutional frameworks governing firm behavior around the world.

institution Formal and informal rules of the game.

institutional framework Formal and informal institutions that govern individual and firm behavior.

Given its equal treatment of companies no matter where they’re from, it is not surprising that Hong Kong attracts businesses from all over the world

societies Conversely, collectivistic societies such as Japan

often have a hard time fostering entrepreneurship Most

people there refuse to stick their neck out to found new

businesses because it is contrary to the norm

Overall, an institution-based view suggests that

in-stitutions shed a great deal of light on what drives firm

performance around the globe Next, we turn to our

sec-ond core perspective

1-3c Second Core Perspective:

A Resource-Based View10

The institution-based view suggests that the success and

failure of firms around the globe are largely determined by

their environment However, insightful as this perspective

is, there is a major drawback If we push this view to its

logical extreme, then firm performance around the globe

would be entirely determined by environments The

valid-ity of this extreme version is certainly questionable

draw-back While the institution-based view primarily deals with

the external environment, the resource-based view focuses

on a firm’s internal resources and capabilities It starts with

a simple observation: In a harsh, unattractive environment,

most firms either suffer or exit However, against all odds,

a few superstars thrive in such an environment For

in-stance, despite the former Soviet Union’s obvious hostility

toward the United States during the Cold War, PepsiCo

began successfully operating in the former Soviet Union

in the 1970s (!) In another example, airlines often lose

money But a small number of players, such as Southwest

in the United States, Ryanair in Ireland, Hainan in China,

and IndiGo in India, have been raking in profits year after

year In the fiercely competitive fashion industry, Zara has

been defying gravity How can these firms succeed in such

a challenging environment? What is special about them?

A short answer is that Hainan, IndiGo, PepsiCo, Ryanair,

Southwest, and Zara must have certain valuable and

unique firm-specific

re-sources and capabilities that are not shared by competitors in the same environment

Doing business side one’s home country is challenging Foreign firms have to overcome a

which is the inherent

resource-based view A leading

perspective in global business that

suggests that firm performance is,

at least in part, determined by its

internal resources and capabilities.

liability of foreignness The

inherent disadvantage that foreign

firms experience in host countries

because of their nonnative status.

globalization The close

integration of countries and peoples

of the world.

differences in regulations, languages, cultures, and norms Think about the odds against Toyota and Honda when they tried to eat some of General Motors’ and Ford’s lunch in the American heartland Against such significant odds, the primary weapons that foreign firms such as Toyota and

Honda employ are overwhelming resources and

capabili-ties that can offset their liability of foreignness Today, many

of us take it for granted that the best-selling car in the United States rotates between the Toyota Camry and the Honda Civic, that Coca-Cola is the best-selling soft drink in Mexico, and that Disney is the world’s number-one theme park operator (see Opening Case) We really shouldn’t

Why? Because it is not natural for these foreign firms to

dominate nonnative markets These firms must possess some very rare and powerful firm-specific resources and capabilities that drive these remarkable success stories This is a key theme of the resource-based view, which fo-cuses on how winning firms develop unique and enviable resources and capabilities and how competitor firms imi-tate and then innovate in an effort to outcompete the win-ning firms

1-3d A Consistent Theme

Given our focus on the fundamental question of what determines the success and failure of firms around the globe, we will develop a unified framework by organizing

the material in every chapter according to the two core

perspectives, namely, the institution-based and based views.12 For example, our Opening Case on Shang-hai Disneyland illustrates both views at work From an institution-based view, it is clear that Disney needs to thoroughly understand the rules of the game in China Being insensitive about local politics and norms (such as

resource-the Kundun incident) can land resource-the firm in big trouble

From a resource-based view, Disney needs to possess valuable and rare capabilities that the Chinese, who are craving for world-class entertainment, cannot get else-where With our unified framework—an innovation in IB textbooks—we will not only explore the global business

“trees,” but also see the global business “forest.”

1-4 WHAT IS GLOBALIZATION?

integra-tion of countries and peoples of the world This abstract five-syllable word is now frequently heard and debated Those who approve of globalization count its contributions

to include greater economic growth, higher standards of

living, increased technology sharing, and more

exten-sive cultural integration Critics argue that globalization

undermines wages in rich countries, exploits workers in

poor countries, gives MNEs too much power, destroys

the environment, and undermines national sovereignty

So what exactly is globalization? This section outlines

three views on globalization, recommends the pendulum

view, and introduces the idea of semiglobalization

1-4a Three Views on Globalization

Depending on what sources you read, globalization

could be one of the following:

▸

times

▸

▸ A long-run historical evolution since the

dawn of human history

▸

extreme to another from time to time

An understanding of these views helps put

the debate about globalization in

per-spective First, opponents of

glo-balization suggest that it is a new

phenomenon beginning in the

late 20th century, driven by

recent technological

inno-vations and a Western

ideo-logy focused on exploiting

and dominating the world

through MNEs The arguments against globalization cus on an ideal world free of environmental stress, social injustice, and sweatshop labor, but present few clear alter-natives to the present economic order Advocates and anti-globalization protesters often argue that globalization needs

fo-to be slowed down, if not sfo-topped

A second view contends that globalization has always been part and parcel of human history Historians debate whether globalization started 2,000 or 8,000 years ago MNEs existed for more than two millennia, with their earli-est traces discovered in Phoenician, Assyrian, and Roman

A.D., the Roman emperor Tiberius was so

concerned about the massive quantity of

low-cost Chinese silk imports that he imposed

the world’s first known import quota of textiles

To-day’s most successful MNEs do not come close to

wield-ing the historical clout of some earlier MNEs, such as the

East India Company during colonial times In a nutshell,

globalization is nothing new and will always exist

A third view suggests that globalization is the “closer

integration of the countries and peoples of the world

which has been brought about by the enormous

reduc-tion of the costs of transportareduc-tion and communicareduc-tion

and the breaking down of artificial barriers to the flows

of goods, services, capital, knowledge, and (to a lesser

extent) people across borders.”13 Globalization is neither

recent nor one-directional It is, more accurately, a

pro-cess similar to the swing of a pendulum

1-4b The Pendulum View on Globalization

The third, pendulum view probably makes the most

sense, because it can help us understand the ups and

downs of globalization The

cur-rent era of tion originated

globaliza-in the aftermath

of World War II, when major West-ern nations committed

to global trade and investment However, between the

1950s and the 1970s, this view was not widely shared

Communist countries, such as the former Soviet Union

and China, sought to develop self-sufficiency Many

noncommunist developing countries such as

Argen-tina, Brazil, India, and Mexico focused on fostering and

protecting domestic industries But refusing

to participate in global trade and investment

ended up breeding uncompetitive industries

In contrast, four developing economies in Asia—namely, Hong Kong, Singapore, South Korea, and Taiwan—earned their stripes as the “Four Tigers” by participating in the global

economy They became the

only economies once

recog-nized as less developed (low-income)

by the World Bank to have subsequently

achieved developed (high-income) status

Latin America in the mid 1980s, Central and Eastern Europe in the late 1980s, and India in the 1990s—realized that joining the world economy was a must As these coun-tries started to emerge as new players in the world economy, they became collectively known

as “emerging economies.” As a result, globalization rapidly accelerated

However, globalization, like a pendulum, is able to keep going in one direction Rapid globaliza-tion in the 1990s and the 2000s saw some significant backlash First, the rapid growth of globalization led

un-to the hisun-torically inaccurate view that globalization

is new Second, it created fear among many people

in developed economies that they would lose jobs Finally, some factions in emerging economies com-plained against the onslaught of MNEs, alleging that they destroy not only local companies, but also local cultures and values

The December 1999 protests in Seattle and the September 2001 terrorist attacks in New York and Washington are undoubtedly some of the most visible and most extreme acts of anti-globalization forces at work As a result, international travel was curtailed, and global trade and investment flows slowed in the early 2000s Then in the mid 2000s, worldwide GDP, cross-border trade, and per capita GDP all soared to historically high levels It was during that period that

“BRIC” became a buzzword

Unfortunately, the party suddenly ended in 2008 The 2008–2009 global economic crisis was unlike any-thing the world had seen since the Great Depression (1929–1933) The crisis showed, for better or worse, how interconnected the global economy has become Dete-riorating housing markets in the United States, fueled by unsustainable subprime lending practices, led to massive government bailouts of failed firms The crisis quickly spread around the world, forcing numerous governments

to bail out their own troubled banks Global output, trade, and investment plummeted while unemployment

skyrocketed The 2008–2009 crisis came known as the Great Recession Many people blamed globalization for the Great Recession

be-After unprecedented ernment intervention in developed economies, confidence was growing that the global economy had turned the corner.14

gov-However, starting in 2010, the Greek debt crisis and then the broader PIGS debt crisis

India

China Brazil

Russia

became slower, and unemployment hovered at very high

levels In 2016, a majority of citizens in Britain, frustrated

by slow growth, high unemployment, endless needs to bail

out troubled countries, and the influx of immigrants, voted

to exit the European Union (EU)—resulting in Brexit

(British exit of the EU) (see Chapter 8 for details)

Also in 2016, Americans voted Donald Trump into

power Departing from earlier American presidents’

inter-est in globalization and free trade, Trump has openly called

for protectionism, nationalism, and isolation He withdrew

US participation in the Trans-Pacific Partnership (TPP),

demanded to renegotiate the North American Free Trade

Agreement (NAFTA), threatened a trade war with China,

and tightened immigration and border control

In contrast, Chinese leaders became defenders of

glo-balization In January 2017, President Xi Jinping made his

first appearance in Davos, Switzerland, an annual gathering

of the world’s pro-globalization political and business elite

His speech argued that “[n]o one will emerge as a winner in

a trade war” and likened protectionism to “locking oneself

in a dark room.”15 In the same month, Premier Li Keqiang,

for the first time among all Chinese leaders, contributed an

article to Bloomberg Businessweek, whose title summed it

well: “Economic openness serves everyone better.”16 It is a

great irony that at a time of global uncertainty and anxiety

for capitalists, the world’s most powerful communist

lead-ers presented themselves as champions of open markets

and globalization In the 1980s, it was the (then) Chinese

leaders who were lectured by American politicians about

the merits of abandoning isolationism and joining the global

economy However, that is exactly why the pendulum view

on globalization is so powerful (see Exhibit 1.5)

The Great Recession, Brexit, and Trump

re-mind all firms and managers of the importance of risk

and the preparation to minimize the impact of high-risk,

unfortunate events As a technique to prepare and plan for

multiple scenarios (either high risk or low risk), scenario

example, what if Britain did completely break ties with the EU? What if NAFTA was dismantled?

Like the proverbial elephant, globalization is seen by everyone yet rarely comprehended Remember all of us felt sorry when we read the story of a bunch of blind men trying

to figure out the shape and form of the elephant We really shouldn’t Although we are not blind, our task is more chal-lenging than the blind men who study a standing animal Our beast—globalization—does not stand still and often rapidly moves, back and forth (!) Yet, we try to live with it, avoid being crushed by it, and even attempt to profit from

it Overall, relative to the other two views, the view of balization as a pendulum is more balanced, more realistic, and thus more insightful In other words, globalization has both rosy and dark sides, and it changes over time

glo-1-4c Semiglobalization

Despite the hype, globalization is not complete Do we really live in a globalized world? Are selling and invest-ing abroad just as easy as at home? Obviously not Most measures of market inte-

gration, such as trade and FDI, have recently scaled new heights, but still fall far short of pointing to a single, globally integrated market Given some countries’ recent retreat from globalization, such measures are likely to be reduced In other words, what we have may be la-beled semiglobalization, which is more complex

EXHIBIT 1.5 THE PENDULUM SWINGS

1980s United States, Britain China

2010s China United States, Britain

risk management Identification and assessment of risks and preparation

to minimize the impact of high-risk, unfortunate events.

scenario planning A technique

to prepare and plan for multiple scenarios (either high or low risk).

semiglobalization A perspective that suggests that barriers to market integration at borders are high, but not high enough to completely insulate countries from each other.

Under President Xi Jinping, China has emerged

as a leading defender of globalization In a recent speech, Xi argued that “No one will emerge as a winner in a trade war.”

Debate: Are US Multinationals Good

for America?

Ethical Dilemma

Most debates on multinational en- terprises (MNEs) around the world focus on their impact on host countries that receive foreign direct investment (FDI) Recent debates

highlight the role of homegrown MNEs in the US economy itself On

the positive side, US MNEs are productive, innovative, employing

more skilled workers, and paying higher wages—at least 6% more

than non-MNEs in the United States Shareholders pocket the fruits

of these firms’ global success, and executives—especially those from

successful firms—enjoy increased power, more pay, and

higher-profile global celebrity status.

However, on the non-positive side, in the past decade US

MNEs have been decoupling from the US economy They still have

headquarters in the United States, are still listed on US stock

ex-changes, and most of their shareholders are still American

(foreign-ers own approximately 15% of US equities) But their expansion

has been mostly overseas Between 2009 and 2013, only 400,000

(5%) of the net jobs created in America were created by US MNEs

In 2007, Delphi filed for Chapter 11 bankruptcy protection in order

to slash its US headcount from 32,000 to 7,000 Its bankruptcy filing

was careful to exclude its 115,000 foreign-based headcount, which

was destined to grow IBM reportedly endeavored to reduce the

number of permanent employees located in the United States from

30% to 20% of its total global headcount by the end of 2017.

US MNEs are also increasingly shy about paying US taxes One

of their leading concerns is one of the world’s highest corporate

income tax rates imposed by Uncle Sam, and many other countries

lure them away with lower taxes Legally, Google Ireland is not

a branch of the US-based Google Corporation Although 100%

owned by Google Corporation, Google Ireland is a separate, legally

independent corporation registered in Ireland Technically, Google

Ireland is an Irish firm Although Google Corporation intentionally

lets Google Ireland earn a lot of profits, the US Internal Revenue

Service (IRS) cannot tax a dime that Google Ireland makes unless

Google Ireland sends back (repatriates) the profits to Google

Corpo-ration Google Corporation does not have just one subsidiary It has

many around the world Overall, 54% of Google’s profits are parked

overseas and are not taxable by the IRS Google is not alone The

list of leading US firms that have left (or invested) a majority of their

profits overseas includes Chevron, Cisco, Citigroup, Exxon Mobil, GE,

HP, Johnson & Johnson, Microsoft, P&G, PepsiCo, and Pfizer.

Overall, in their eagerness to chase new markets, cheap labor,

and lower taxes by “going global,” many US MNEs, according to

crit-ics, have abandoned some of their most important corporate social

responsibility (CSR) They stand accused of unleashing “carnage”

on ordinary Americans, in the words of President Trump during his inaugural speech in January 2017 The solution? “Domesticate”

such globe-trotting multinationals, according to the Economist

Lower taxes would draw them back, and open threats with “a big border tax” (again, Trump’s own words) would make them think twice before “doing business as usual.” The list of US MNEs being publicly named and shamed by Trump includes Boeing, Carrier (part

of United Technologies), General Motors, Northrop Grumman, and others Getting the message, Apple, Ford Motor Company, IBM, and other US MNEs, including those named above, have pledged to grow thousands of jobs at home Non-US firms such as Alibaba, Fiat Chrys- ler, and Toyota have also played along by pledging to invest in the United States and grow jobs there—at least to avoid being Trump’s next Twitter victim.

Are these pledges “smoke screens,” or are they the beginning

of a new era? Are these moves good or bad for the US economy? Of course, given the complexity, “good” is simply a shorthand for benefits outweighing drawbacks, and “bad” is the other way around

Abandoning the benefits of low-cost labor and employing high-cost American labor would jack up the price of goods and services Few would appreciate this outcome An official Made-in-USA “Make America Great Again” hat costs $25, but a Made-in-China hat only costs

$15 (or less) If US MNEs shifted a quarter of their foreign jobs back home at US wage levels, their profits would drop 12%, and dividends would plummet Clearly, shareholders and executives are not going to

be happy Debates on how to strike the balance thus rage on.

Sources: “IBM’s big jobs dodge,” Bloomberg Businessweek, 30 January 2017: 30;

“Trump’s uncertainty principle,” Bloomberg Businessweek, 30 January 2017: 6–7;

“Go bankrupt, then go overseas,” Business Week, 24 April 2006: 52–53; “In retreat,” Economist, 28 January 2017: 11; “The retreat of the global company,” Economist,

28 January 2017: 18–22; M W Peng, Global Business, 4th ed (Boston: Cengage, 2017).

gration at borders are high, but not high enough to

insu-late countries from each other completely.17

Semiglobalization calls for more than one way of strate

-gizing around the globe Total isolation on a nation-state

basis would suggest localization—a strategy of treating each

country as a unique market An MNE marketing products

to 100 countries will need to come up with 100 versions

This strategy is clearly too costly Total globalization, on

the other hand, would lead to standardization—a strategy

of treating the entire world as one market The MNE can

just market one version of “world car” or “world drink.”

But the world obviously is not that simple Between total

isolation and total globalization, semiglobalization has no

single right way of doing business around the globe,

result-ing in a wide variety of experimentations Overall, (semi)

globalization is neither to be opposed as a menace nor to

be celebrated as a panacea; it is to be engaged.

1-5 A GLANCE AT THE GLOBAL

ECONOMY

Twenty-first-century business leaders face enormous

chal-lenges (see Debate) This book helps overcome some of

these challenges As a backdrop for the remainder of

this book, this section offers a basic

understand-ing of the global economy The global economy

in 2015 was an approximately $75 trillion

economy (total global GDP calculated at

of-ficial, nominal exchange rates—alternatively,

$110 trillion on a PPP basis).18 Although there is

no need to memorize a lot of statistics, it

is useful to remember this $75 trillion

(or $110 trillion) figure to put things

in perspective

One frequent observation

in the globalization debate

is the enormous size and

power of multinationals

(see Debate) Take a look

at the largest MNE within one

sizable country: Volkswagen’s

worldwide sales would

repre-sent 10% of German GDP,

Samsung’s sales 17% of South

Korean GDP, and BP’s sales

Ex-hibit  1.6 shows the most

recent top ten firms If the

largest MNE, Walmart, were an independent country, it would be the 27th largest economy—its sales were smaller than Belgium’s GDP but larger than Venezuela’s The sales

of the largest EU-based MNE, Royal Dutch Shell, were larger than the GDP of each of the following EU mem-ber countries: Austria, Denmark, Finland, Ireland, and Portugal The sales of the largest Asia-based MNE, State Grid, were larger than the GDP of each of the following Asian economies: Hong Kong, Malaysia, Phillippines, Singapore, and Thailand Today, over 82,000 MNEs manage at least 810,000 subsidiaries overseas.20 Total annual sales for the largest 500 MNEs reach $28 trillion (more than one third of global output).21

Exhibit 1.7 documents the change

in the makeup of the 500 largest MNEs Although MNEs from the Triad (North America, Europe, and Japan) dominate the list, their share has been shrinking—thanks to the Great Transformation (dis-cussed earlier) Among MNEs from emerging economies, those from BRIC contribute 122 firms

to the Fortune Global 500 list In

particular, MNEs from China have come on strong.22 With

57 Fortune Global 500

company headquarters, Beijing now has the heaviest

IN THE WORLD (MEASURED BY SALES)

Corporate name Country

1 Walmart Stores United States

2 State Grid China

3 China National Petroleum

Corporation China

4 Sinopec Group China

5 Royal Dutch Shell Netherlands

6 Exxon Mobil United States

7 Volkswagen Germany

8 Toyota Motor Japan

9 Apple United States

10 BP United Kingdom

Source: Adapted from Fortune, “Global 500,” 1 August 2016: F-1 Data refer to 2015.

ISTOCK.COM/ZONECREATIVE

ond heaviest concentration) London, New York, and Paris

each have 17 (third heaviest concentration) Clearly, global

rivals cannot afford to ignore emerging multinationals such

as those based in Beijing, and students studying this book

need to pay attention to these emerging multinationals

1-6 ORGANIZATION OF THE BOOK

This book has three parts Part 1 is foundations Following

this chapter, Chapters 2, 3, and 4 deal with the two leading

perspectives: institution-based and resource-based views

Part 2 covers tools, focusing on trade (Chapter 5), foreign

investment (Chapter 6), foreign exchange (Chapter 7), and

global and regional integration (Chapter 8) Part 3 focuses

on managing around the world We start with the

interna-tionalization of small, entrepreneurial firms (Chapter  9),

followed by ways to enter foreign markets (Chapter 10), to

make alliances and acquisitions work (Chapter 11), to

strate-gize, structure, and learn (Chapter 12), to manage human

resources (Chapter 13), to deal with marketing and supply

chain management (Chapter 14), and finally to manage

cor-porate social responsibility (Chapter 15)

FORTUNE GLOBAL 500

2005 2010 2015

Developed economies

United States 170 133 134 European Union 165 149 124

Focusing on the future of the

global economy, two scenarios have emerged with a view toward 2050

Known as “continued globalization,” the first

scenario is a rosy one Spearheaded by Goldman

Sachs, whose chairman of its Asset Management

Division, Jim O’Neil, coined the term “BRIC” nearly two decades

ago, this scenario suggests that—in descending order—China,

the United States, India, Brazil, and Russia will become the largest

economies by 2050 (Exhibit 1.8) BRIC countries together may

overtake the US by 2015 and the Group of Seven (G-7) by 2032,

and China may individually dethrone the US by 2026 In PPP

terms, BRIC’s share of global GDP, which rose from 18% in 2001 to

25% currently, may reach 40% by 2050 In addition, by 2050, the

N-11 as a group may become significantly larger than the United

States and almost twice the size of the Euro area

Goldman Sachs’ predictions have been largely supported by

other influential forecasting studies For example, the Organization

for Economic Cooperation and Development (OECD) predicted

that by 2060, China, India, and the United States will become the top three economies The combined GDP of China and India will

be larger than that of the entire OECD area (Exhibit 1.9) In 2011, China and India accounted for less than one-half of GDP of the seven major (G-7) OECD economies By 2060, the combined GDP

of China and India may be 1.5 times larger than the G-7 India’s GDP will be a bit larger than the United States’, and China’s a lot larger.Despite such dramatic changes, one interesting constant

is the relative rankings of income per capita Goldman Sachs predicted that by 2050, the G-7 countries will still be the richest, led by the United States, Canada, and the United Kingdom (Exhibit 1.10) Ranked eighth globally ($63,486—all dollar figures in this paragraph refer to 2010 US dollars), Russia may top the BRIC group, with income per capita approaching that of Korea By 2050, per capita income in China ($40,614) and India ($14,766) will continue to lag behind developed economies—at, respectively, 47% and 17% of the US level ($85,791) These predictions were supported by the OECD, which noted that by 2060, Chinese and Indian per capita

income would only reach 59% and 27% of the US level,

respectively

Underpinning this scenario of “continued globalization”

are three assumptions: (1) Emerging economies as a group

will maintain strong (albeit gradually reduced) growth; (2)

geopolitical events and natural disasters (such as climate

changes) will not create significant disruption; and (3) regional,

international, and supranational institutions will continue to

function reasonably This scenario envisions a path of growth

that is perhaps more volatile than that of the past 20 years,

but ultimately leads to considerably higher levels of economic

integration and much higher levels of incomes in countries

nowadays known as emerging economies

The second scenario can be labeled “de-globalization.” It is

characterized by (1) prolonged recession, high unemployment,

droughts, climate shocks, disrupted food supply, and conflicts

over energy (such as “water wars”), on the one hand; and

(2) public unrest, protectionist policies, and the unraveling of

certain institutions that we take for granted (such as the EU and NAFTA), on the other hand As protectionism rises, global economic integration suffers

The upshot? Weak economic growth around the world While global de-integration would harm economies worldwide, regional de-integration would harm countries of Europe, especially those outside a likely residual core of the EU Brexit will make Britain a weaker economy Unable to keep growing sustainably, BRIC may become “broken bricks” and may fail to reach their much-hyped potential For example, in the 1950s and 1960s, Russian economic growth was also very impressive, fueling Soviet geopolitical ambitions that eventually turned out to

be unsupportable In the late 1960s, Burma (now Myanmar), the Philippines, and Sri Lanka were widely anticipated to become the next Asian Tigers, only to falter badly Over the long course

of history, it is rare to sustain strong growth in a large number of countries over more than a decade It is true that the first decade

of the 21st century—prior to the Great Depression—witnessed

Source: Goldman Sachs, “An update on the long-term outlook for the BRICs and beyond,” Monthly Insights from the Office of the Chairman, Goldman Sachs Asset Management (January 2012):

3 “N-11” refers to the Next Eleven identified by Goldman Sachs: Bangladesh, Egypt, Indonesia, Iran, Korea, Mexico, Nigeria, Pakistan, Philippines, Turkey, and Vietnam.

Australia Argentina Malaysia Colombia Thailand Vietnam Poland

South Africa Bangladesh

Japan 7%

2060 2011

Euro area 17%

Other OECD 18%

Other OECD 11%

non-China 17%

Other OECD 14%

Other OECD 11%

non-China 28%

India 18%

some spectacular growth in BRIC and many other emerging

economies A key question concerns how unique the current

times are Historically, “failure to sustain growth has been the

general rule,” according to a pessimistic expert

In both scenarios, one common prediction is that

global competition will heat up Competition under the

“de-globalization” scenario would be especially intense since the total

size of the “pie” will not be growing sufficiently (if not negatively)

At the same time, firms would operate in partially protected

markets, which result in additional costs for market penetration

Competition under the “continued globalization” scenario would

also be intense, but in different ways The hope is that a rising

“tide” may be able to lift “all boats.”

Case Discussion Questions

1 Which of the two scenarios is more plausible for the global

economy in 2050? Why? How does that affect you as a

consumer, as a professional, and as a citizen of your country?

2 From a resource-based view, what should firms do to better prepare for the two scenarios?

3 ON ETHICS: From an institution-based view, what should

firms do to better prepare for the two scenarios? (Hint: For

example, if they believe in “continued globalization,” they may be more interested in lobbying for reduced trade barriers But if they believe in “de-globalization,” they may lobby for higher trade barriers.)

Source: “In retreat,” Economist, January 28, 2017: 11; “The retreat of the global company,” Economist, 28 January 2017: 18–22; Foresight Horizon Scanning Centre, World Trade: Possible Futures (London: UK Government Office for Science, 2009);

Goldman Sachs, “An update on the long-term outlook for the BRICs and beyond,”

Monthly Insights from the Office of the Chairman, Goldman Sachs Asset Management, January 2012; A Musacchio and E Werker, “Mapping frontier economies,” Harvard Business Review, December 2016: 41–48; OECD, “Looking to 2060: A global vision of long-term growth,” Economics Department Policy Note 5, November 2012; M W Peng and K Meyer, Winning the Future Markets for UK Manufacturing Output (London: UK

Government Office for Science, 2013); R Sharma, “Broken BRICS: Why the rest stopped

growing,” Foreign Affairs, November 2012: 2–7.

Source: Goldman Sachs, “An update on the long-term outlook for the BRICs and beyond,” Monthly Insights from the Office of the Chairman, Goldman Sachs Asset Management (January 2012):

4 See footnote to Exhibit 1.8 for N-11.

2010 US$/capita

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After studying this chapter, you will be able to . . .

2-1 Identify two types of institutions.

2-2 Explain how institutions reduce

uncertainty.

2-3 Identify the two core propositions

underpinning an institution-based view

Opening Case: The Newest Transition Economy

T he term “transition economy”

was coined in the mid-1990s

to refer to former Soviet Union and Central and Eastern European countries (such as Hungary, Poland, and Russia) as well as Asian countries (such as China and Vietnam), which were undergoing major transitions from state socialism toward market capitalism Specifically, institutional transitions are defined as fundamental and comprehensive changes introduced to the formal and informal rules of the game that affect firms as players

How firms—both domestic and foreign, established and newly founded—navigate the uncertain waters of such transitions has been a major theme in the global business field since the 1990s

Fast-forward to 2017 The United States has emerged to become the newest “transition economy,” with numerous rules of the game being significantly changed by the Trump administration

Politically, the country has remained a functioning democracy The peaceful transition of power in January 2017, despite a divisive campaign, continues the country’s admirable tradition that started during President George Washington’s time Elsewhere, such a peaceful transition of power cannot be taken for granted Speaking

of coincidence, the tiny African nation of Gambia also elected a new president in late 2016, but the incumbent president who lost the election refused to leave Political chaos and violence erupted

Thousands of people fled On January 21, 2017, the incumbent president had to be militarily dislodged by foreign troops from the Economic Community of West African States (ECOWAS) so that the newly elected president could be sworn in—literally at the same time when Donald Trump was sworn in

Economically, the changes unleashed by the Trump administration are numerous and wide-ranging Turning inward, the United States would shy away from embracing the long-cherished principles of globalization and free trade US participation in the Trans-Pacific Partnership (TPP), a free trade deal that negotiators from the United States and 11 other countries labored over for seven years and that had been signed (but not yet ratified by Congress) in 2016, was withdrawn by the stroke

of a pen in an executive order during the first week of the new administration Although well established since 1994, the North American Free Trade Agreement (NAFTA) would be renegotiated,

if not dismantled Firms such as Carrier, General Motors (GM), and

Toyota that took advantage of NAFTA were publically named and shamed for “shipping US jobs” to Mexico They were coerced to agree to invest in the US economy Otherwise, these firms were threatened with—in Trump’s own words—a “big border tax,”

which would be a violation of NAFTA Getting the message, Fiat Chrysler and Ford Motor Company quickly announced expansion plans in the United States to avoid Trump’s wrath Looming on the horizon is a trade war with China, the world’s largest trader and one of the United States’ leading trading partners

Politically, Trump’s rapid-fire executive orders banning refugees from seven Muslim-majority countries, erecting a wall along the border with Mexico, and emphasizing “extreme vetting” touched off a storm of protests Firms ranging from low-tech agribusinesses to high-tech Silicon Valley fast movers, which rely

on immigrant labor and talents, had to brace themselves Trump’s actions also generated a series of lawsuits from various groups, alleging that the presidential actions were unconstitutional and disrespecting the rule of law Although such allegations were not unusual for presidents in countries such as Gambia, it is rare for a US president to be so labeled One thing “a president who prides himself on changing all the rules and throwing away the

established norms,” according to Bloomberg Businessweek, has

accomplished is to introduce tremendous uncertainties amid all these transitions

Affecting politics, laws, and economics, uncertainties are a hallmark of all transition economies, whose future direction, by definition, is unpredictable Will the future of the United States as the newest transition economy be “great again” as promised by President Trump, or join the ranks of “failed states” as prophesized

by a leading American political scientist, Francis Fukuyama

(whose most famous earlier work is his 1992 book The End of History and the Last Man)?

Sources: “The arc of Trump,” Bloomberg Businessweek, 28 November 2016: 6–7;

“Silicon Valley’s new reality show,” Bloomberg Businessweek, 12 December 2016: 6–7;

“Pharma’s worst nightmare,” Bloomberg Businessweek, 23 January 2017: 18–19; “The looming Trump trade disaster,” Bloomberg Businessweek, 23 January 2017: 8; “The patriotic response to populism,” Bloomberg Businessweek, 9 January 2017: 8; “Trump’s uncertainty principle,” Bloomberg Businessweek, 30 January 2017: 6–7; “Trump vs the rule of law,” Bloomberg Businessweek, 6 February 2017: 6–7; “Troops enter Gambia as new president is sworn in,” New York Times, 19 January 2017: www.nytimes.com;

F Fukuyama, “America: The failed state,” Prospect Magazine, January 2017: www prospectmagazine.co.uk; M W Peng, Business Strategies in Transition Economies (Thousand Oaks, CA: Sage, 2000); “Auto industry’s no 1 preoccupation: Trump,” Wall Street Journal, January 23, 2017: www.wsj.com.

transitions? How do the rules of the game and their changes affect domestic and foreign firms as players? Why are the stakes so high? As the Opening Case illustrates, the answer boils down to institutions,

popularly known as the “rules of the game” (first duced in Chapter 1) As economic players, individuals and firms play by these rules However, institutions are not static and they may change, as evidenced

intro-by the ongoing changes in the United States Such

mal rules of the game that affect firms as players.”1

Overall, the success and failure of firms around the

globe are to a large extent determined by firms’ ability to

understand and take advantage of the different rules of

the game In other words, how firms play the game and

win (or lose), at least in part, depends on how the rules

are made, enforced, and changed This calls for firms to

constantly monitor, decode, and adapt to the changing

rules of the game in order to survive and prosper As a

result, such an institution-based viewhas emerged as a

leading perspective on global business.2 This chapter first

introduces the institution-based view Then, we focus on

formal institutions (such as political, legal, and economic

systems) Informal institutions (such as cultures, ethics,

and norms) will be discussed in Chapter 3

2-1 UNDERSTANDING INSTITUTIONS

Building on the “rules of the game” metaphor, Douglass

North, a Nobel laureate in economics, more formally

defines institutions as “the humanly devised constraints

that structure human interaction.”3 An institutional

framework is made up of both the formal and

infor-mal institutions governing individual and firm behavior

Richard Scott, a leading sociologist, identifies three

pil-lars that support these institutions: regulatory,

norma-tive, and cognitive.4

Shown in Exhibit 2.1, formal institutions include

laws, regulations, and rules Their primary supportive

pillar, the regulatory pillar,is the coercive power of

governments For example, out of patriotic duty, many

individuals may pay taxes However, many other

in-dividuals pay taxes out

of fear—if they did not pay and got caught, they would go to jail In other words, it is the coercive power of governments’

tax laws that forms the regulatory pillar to com-pel many individuals to pay taxes

On the other hand, informal institutions in-clude norms, cultures, and ethics Informal in-stitutions are supported

by two pillars: normative

norms—of other relevant players influence the vior of focal individuals and firms For example, a recent norm among Western firms is the rush to invest in China and India This norm has prompted many Western firms

beha-to imitate each other without a clear understanding of how to make such moves work Cautious managers who resist such herding are often confronted by board mem-bers and investors with the question “Why are we not in China and India?” In other words, “Why don’t we follow the norm?”

infor-mal institutions It refers to the internalized (or for-granted) values and beliefs that guide individual and firm behavior For example, whistleblowers reported Enron’s wrongdoing out of belief in what is right and wrong While most employees may not feel comfortable with organizational wrongdoing, the social norm in any firm is to shut up and not to rock the boat Essentially, whistleblowers choose to follow their internalized per-sonal belief on what is right by overcoming the social norm that encourages silence In Enron’s case, the nor-mative pillar suggests silence, whereas the whistleblow-ers’ actions are supported by their strong cognitive pillar regarding what is right and wrong

taken-Formal and informal institutional forces stem marily from home countries and host countries In ad-dition, international and regional organizations such as the World Trade Organization (WTO), the International Monetary Fund (IMF), and the European Union (EU) may also influence firm conduct in terms of do’s and don’ts See Chapters 7 and 8 for more details

pri-institutional transition

Fundamental and comprehensive

changes introduced to the formal

and informal rules of the game that

affect organizations as players.

regulatory pillar The coercive

power of governments exercised

through laws, regulations, and rules.

normative pillar The mechanisms

through which norms influence

individual and firm behavior.

cognitive pillar The internalized,

taken-for-granted values and beliefs

that guide individual and firm

behavior.

EXHIBIT 2.1 DIMENSIONS OF INSTITUTIONS

Degree of formality Examples Supportive pillars

Formal institutions LawsRegulations

Rules

Regulatory (coercive)

Informal institutions NormsCultures

Ethics

Normative Cognitive

tal, rich people in Africa put a striking 39% of their assets outside of Africa.7

Institutions are not static Institutional transitions

in some emerging economies are so pervasive that

these countries are simply called transition economies Examples include those countries that are moving from central planning to market com-petition, such as China, Cuba, Poland, and Russia Institutional transitions in these countries as well as other emerging economies such as Brazil, India, and South Africa create both huge chal-lenges and tremendous opportuni-ties for domestic and international firms The Opening Case suggests that the United States has become a new transition economy

Having outlined the definitions of ous institutions and their suppor tive pillars as well as the key role of institutions in uncer-tainty reduction, next we will introduce the first core perspective on global business: an institution-based view

vari-2-3 AN INSTITUTION-BASED VIEW

OF GLOBAL BUSINESS

Shown in Exhibit 2.2, an institution-based view of global business focuses on the dynamic interaction between institutions and firms, and considers firm behavior as the outcome of such an interaction Specifically, firm behavior is often a reflection of the formal and informal constraints of a particular institutional framework In short, institutions matter

How do institutions matter? The institution-based view suggests two core propositions (see Exhibit 2.3)

First, managers and firms rationally pursue their

inte-rests and make choices within institutional constraints

In Brazil, government tax revenues at all lev-els reach 35% of GDP, much higher than Mex-ico’s 18% and China’s 16% Not surprisingly, the gray market in Brazil

While institutions do many things, their key role is to

reduce uncertainty Specifically, institutions influence

the decision-making process of both

indi-viduals and firms by signaling what

conduct is legitimate and

accept-able and what is not Basically,

institutions constrain the range

of acceptable actions Why is it

so important to reduce uncertainty?

Because uncertainty can be potentially

devastating Political uncertainty such as an

upris-ing may render long-range plannupris-ing obsolete Political

deadlocks in Washington have made the US government

“less stable, less effective, and less predictable,” which

led Standard & Poor’s—a private but influential

rating agency—to downgrade its AAA credit

failure to carry out transactions as spelled

out in contracts may result in economic

losses See the Closing Case for the

ongo-ing political and economic uncertainty

in Russia

Uncertainty surrounding

eco-nomic transactions can lead to

associated with economic transactions

or, more broadly, the costs of doing

business Nobel laureate Oliver Williamson makes the

comparison to frictions in mechanical systems: “Do the

gears mesh, are the parts lubricated, is there needless

slippage or other loss of energy?” He goes on to suggest

that transaction costs can be regarded as “the economic

counterpart of frictions: Do the parties to exchange

operate harmoniously, or are there frequent

misunder-standings and conflicts?”6

An important source of transaction costs is

with guile Examples include misleading, cheating, and

confusing other parties in transactions that will increase

transaction costs Attempting to reduce such

transac-tion costs, institutransac-tional frameworks increase certainty

by spelling out the rules of the game so that violations

(such as failures to fulfill contracts) can be mitigated

with relative ease (such as through formal courts and

arbitration)

Without stable institutional frameworks,

transac-tion costs may become prohibitively high, and certain

transactions simply would not take place For example,

in the absence of credible institutional frameworks that

opportunism The act of seeking self-interest with guile.

accounts for a much higher percentage of the economy

States, firms such as Fiat Chrysler, Ford, GM, and

Toyota were eager to take advantage of NAFTA’s

provi-sions to remove tariffs for cross-border movements of

vehicles and parts Under the threat of a “big border

tax,” their response to curtail expansion in Mexico and

to beef up investments in the United States also made

sense (see Opening Case) Both Brazilian firms’

migra-tion to the gray market and US and non-US automakers’

interest in taking advantage of NAFTA are rational

re-sponses when they pursue their interests within formal

institutional constraints in these countries

Second, while formal and informal institutions

com-bine to govern firm behavior, informal constraints play

a larger role in reducing uncertainty and providing

con-stancy for managers and firms in situations where

for-mal constraints are unclear or fail For example, when

the former Soviet Union collapsed and with it the

for-mal regime, the growth of many entrepreneurial firms

was facilitated by informal constraints based on personal

relationships and connections (called blat in Russian)

among managers and officials

Many observers have the impression that relying on

informal connections is relevant only to firms in

emerg-ing economies and that firms in developed economies

pursue only market-based strategies This is far from

the truth Even in developed economies, formal rules

make up only a small (though important) part of

institu-tional constraints, and informal constraints are pervasive

Just as firms compete in product markets, firms also fiercely compete in the political marketplace characterized by informal

the competition on other grounds—namely, the nonmarket, political en-vironment In September 2008, a rapidly failing Merrill Lynch was able

to sell itself to Bank of America for $50 billion Supported by US government officials, this mega deal was arranged over 48 hours (shorter than the time most people take to buy a car) and the

negotiations took place inside the

Fede-ral Reserve building in New York In contrast, Lehman Brothers failed to secure government support and had

to file for bankruptcy In December

2016, Donald Trump’s former campaign manager set

up a lobbying firm, Avenue Strategies It quickly landed

11 clients, including an Ohio payday lender, a Cleveland law firm, and an incoming governor of Puerto Rico.10 Guess what Avenue Strategies will be selling? Overall, the skillful use of a country’s institutional frameworks to acquire ad-vantage is at the heart of the institution-based view While there are numerous formal and informal in-

stitutions, in this chapter we focus on formal institutions

(Informal institutions will be covered in Chapter 3.) Chief among formal institutions are political systems, legal sys-tems, and economic systems We introduce each in turn

2-4 POLITICAL SYSTEMS

how a country is governed politically At the broadest level, there are two primary political systems: democracy and totalitarianism This section first outlines these two systems and then discusses their ramifications for politi-cal risk

Institutions interactionDynamic Firms

Firm Behaviors

Formal and informal

constraints

Industry conditions and firm-specific resources and capabilities

EXHIBIT 2.3 TWO CORE PROPOSITIONS

OF THE INSTITUTION-BASED VIEW

Managers and firms rationally pursue their

interests and make choices within the formal and informal constraints in a given institutional framework.

While formal and informal institutions combine

to govern firm behavior, in situations where formal constraints are unclear or fail, informal

constraints will play a larger role in reducing

uncertainty and providing constancy to managers and firms.

political system The rules of the

game on how a country is governed

politically.

citizens elect representatives to govern the

country on their behalf Usually, the

politi-cal party with the majority of votes wins and

forms a government Democracy was

pio-neered by the Athenians in ancient Greece

In today’s world, Great Britain has the

lon-gest experience of running a democracy (by

history), and India has the largest

democ-racy (by population)

A fundamental aspect of democracy

that is relevant to global business is an

individual’s right to freedom of expression

and organization For example, starting up

a firm is an act of economic expression,

essentially telling the rest of the world:

“I want to be my own boss! And I want

to make some money!” In most modern

democracies, the right to organize

eco-nomically has been extended not only to

domestic individuals and firms, but also

to foreign individuals and firms that come

to do business While those of us fortunate

enough to have been brought up in a

de-mocracy take the right to establish a firm for granted,

we should be reminded that this may not necessarily be

the case under other political systems Before the 1980s,

if someone dared to formally establish a private firm in

the former Soviet Union, he or she would have been

ar-rested and shot by the authorities.

2-4b Totalitarianism

On the opposite end of the political spectrum from

de-mocracy is totalitarianism (also known as dictatorship),

which is defined as a political system in which one

per-son or party exercises absolute political control over the

population There are four major types of totalitarianism:

▸

commu-nist party This system was embraced throughout

Central and Eastern Europe and the former Soviet

Union until the late 1980s It is still practiced in

China, Cuba, Laos, North Korea, and Vietnam

▸

intense hatred of communism One party, typically

backed by the military, restricts political freedom

because its members believe that such freedom

would lead to communism In the decades

fol-lowing World War II, Argentina, Brazil, Chile,

South Africa, South Korea, and Taiwan practiced

right-wing totalitarianism Most of these countries have recently become democracies

▸

monopolization of political power in the hands

of one religious party or group Iran and Saudi Arabia are leading examples

▸

ethnic group (which may or may not be the majority

of the population) monopolizing political power and oppressing other tribes or ethnic groups Rwanda’s bloodbath in the 1990s was due to some of the most brutal practices of tribal totalitarianism

2-4c Political Risk

While the degree of hostility toward business varies among different types of totalitarianism (some can be more pro-business than others), to-

talitarianism in general is not as good for business

as democracy Totalitarian countries often experience wars, riots, protests, chaos, and breakdowns As a re-sult, these countries often suffer from a high level

Marchers carry images of late Cuban President Fidel Castro

at the 2016 International Workers’ Day Parade in Havana, Cuba Raúl Castro, who assumed control of Cuba from brother Fidel in 2008, continues to operate the country as a communist dictatorship

democracy A political system in which citizens elect representatives

to govern the country on their behalf.

totalitarianism (dictatorship) A political system in which one person

or party exercises absolute political control over the population.

changes that may negatively impact domestic and foreign

firms.11 The most extreme political risk may lead to

nation-alization (expropriation) of foreign assets This happened in

many totalitarian countries from the 1950s through the 1970s It has not become a thing of the past Recently, Argentina expropriated the

assets of YPF—the subsidiary of a major Spanish oil firm Repsol Zimbabwe demanded that foreign mining compa-nies cede 51% of their equity without compensation It is hardly surprising that foreign firms are sick and tired and would rather go to “greener pastures” elsewhere

Firms operating in democracies also confront cal risk, but such risk is qualitatively different than that

politi-in totalitarian countries Shown politi-in the Openpoliti-ing Case, nificant transitions have been introduced by the Trump

Testing the Dell Theory of Peace

in East Asia

Thomas Friedman, a New York Times columnist, suggested in his

2005 bestseller The World Is Flat a Dell theory of peace: No two

countries that are both part of a major global supply chain, like

Dell’s, will ever fight a war against each other as long as they are

both part of the same global supply chain Countries involved

in major global supply chains focus on just-in-time deliveries of

goods and services, which raise standards of living for all involved

In the case of Dell, the following countries are involved: China,

Costa Rica, Germany, Israel, Japan, Malaysia, the Philippines, South

Korea, Taiwan, Thailand, and the United States.

East Asia is both a manufacturing hub for IT giants such as Dell

and a hot neighborhood for territorial disputes In 2012, the Japanese

government ignored warnings from China and purchased from a

right-wing politician five barren rocks in the East China Sea, which the

Chinese call Diaoyu and the Japanese call Senkaku (For compositional

simplicity, we will call them the Diaoyu/Senkaku islands in the rest

of In Focus.) Totaling less than three square miles, the uninhabited

islands have long been disputed In 1972, China and Japan agreed

to shelve the issue indefinitely Fast-forward to 2012: the Japanese

government nationalized the islands, in fear of a right-wing politician

whose plans for the islands would certainly have provoked China

But an assertive China argued that even the Japanese government’s

purchase was an unacceptable change in the status quo

Anti-Japanese riots and boycotts erupted in some Chinese cities in August

and September 2012, vandalizing stores selling Japanese products,

burning Japanese-branded cars, and setting a Panasonic factory

on fire Sales of Toyota, Honda, Nissan, and Mazda cars in China

plummeted in the remainder of 2012 Chinese business and tourist

visitors also canceled visits and vacations, and hotels, resorts, and

restaurants in Japan were also hurt—All Nippon Airlines (ANA) alone

suffered 46,000 seat cancellations In all, between 0.5% and 1% of

Japanese GDP was shaved off—all for a bunch of barren rocks.

Since then, Chinese and Japanese ships and aircraft

routinely face off each other in the disputed waters and airspace

surrounding the Diaoyu/Senkaku islands Will such a new cold

war turn hot? Most experts believe this to be unlikely, simply because China needs Japanese products as much as Japan needs

to sell them Japan provides some of the most critical components for made-in-China exports—think of the Sharp LCD screens and Toshiba flash memory drives that power the Apple iPhones assembled in China Japan is also one of the largest foreign direct investors in China, employing approximately 1.5 million workers

in 4,600 factories throughout the country One-tenth of Japan’s foreign direct investment (FDI) stock is in China Because the two economies are complementary, there is a great deal of economic integration characterized by dense trade, investment, and personnel flows Neither side risks disrupting these flows through conflicts without crippling its own economy—or both economies Although there is no guarantee that cooler heads would always prevail in Beijing and Tokyo, Thomas Friedman and peace lovers

of the world—a group that presumably includes all readers of this

book—certainly hope that the Dell theory of peace will continue

to be supported in East Asia and beyond.

Sources: “Japan, China, and a pile of rocks,” Bloomberg Businessweek, 22 October 2012: 20–21; “Battered in China, Japan Inc seeks refuge,” Bloomberg Businessweek, 11 February 2013: 11–12; “Hot oil on troubled waters,” Economist, 17 May 2014: 38; “Beijing’s brand ambassador,” Foreign Affairs, July 2013: 10–17; “Japan is back,” Foreign Affairs, July 2013: 2–8; T Friedman, The World Is Flat (New York: Farrar, Straus and Giroux, 2005); R Katz,

“Mutual assured production: Why trade will limit conflict between China and Japan,”

Foreign Affairs, July 2013: 18–24.

political risk Risk associated with

political changes that may negatively

impact domestic and foreign firms.

Debate: Is Democracy Good for Economic

Development?

Emerging Markets/Ethical Dilemma

Democracy is good Dictator- ship is bad

Although crude, these two state- ments fairly accurately summarize the political sentiments in many parts of the

world It is not hard to understand why Compared with

dictator-ships, on average, democracies are richer, less corrupt, and less

likely to go to war Beyond such nontrivial benefits, deep down,

democracies allow people to make their own political choices In

the second half of the 20th century,

the march of democracy was

impres-sive This powerful idea took root in

some of the most difficult terrains In

Germany, Nazism had to be defeated

militarily In India, the world’s largest

population of poor people had to

be taught how to vote In Japan,

emperor worship had to be curtailed

and military adventurism destroyed

In South Africa, apartheid had to be

dismantled Throughout Asia and

Africa, decolonization gave birth to

a number of new democracies A series of autocratic governments

gave themselves up to democracy: Spain (1975), Argentina (1983),

Brazil (1985), South Korea (1987), Taiwan (1988), and Chile (1989)

The collapse of the Soviet Union (1991) resulted in the proliferation

of young democracies throughout Central and Eastern Europe as

well as Central Asia Recently, the Arab Spring expanded democracy

to North Africa: Algeria (2011), Egypt (2011), and Libya (2011)

Over-all, there is no doubt that democracy has spread around the world:

from 69 countries in the 1980s to 120 in the 2000s.

However, according to the Economist, democracy is “going

through a difficult time.” In new democracies such as Egypt, Iraq, Libya,

Thailand, and Ukraine, an unenviable pattern emerges: it seems easier

to get rid of the old regime than to establish a functioning democratic

government The new regime fumbles, the economy suffers, jobs

disappear, and people find their conditions to be as bad as they were

before Civil disturbance broke out in Iraq and Libya, military coups

smashed democracy in Egypt and Thailand, and foreign intervention

(from Russia) pushed Ukraine’s vulnerable democracy to its limits.

At the same time, established democracies have not been

good role models The United States has become a joke for

dys-functional politics—with partisan politicians shutting down the

federal government once (2013) and threatening to default on its

debt twice (2011 and 2013) The democratically elected President

Donald Trump has attracted waves of protests (2016 and 2017) The European Union is hardly a paradise for democracy either The fateful decision to introduce the euro in 1999 was largely dictated to the public In the only two EU countries that held a democratic referen- dum on whether to adopt the euro—Denmark and Sweden—

voters resoundingly said, “No.” Not surprisingly, many ordinary people in Europe who had to cough up higher taxes to plug the hole

of the recent euro mess were mad When British voters were offered

a chance to vote “Remain in” or “Leave” the EU, a majority of them (52%) voted in favor of Brexit The economic impact was immediate and devastating Within days of the referendum, the pound took

a severe pounding, plummeting to its lowest level against the dollar in three decades Overall, far from marching to dominate the world, democracy seems to have lost its forward momentum lately One of the litmus tests is: Is democ- racy good for economic development? Although champions of democracy shout,

“Yes,” the fastest-growing major economy

in the last three decades, China, remains totalitarian The growth rate of India, the world’s largest democracy, in the same period is only about half of China’s With little democracy, Hong Kong has achieved enviably higher per capita income than its old colonial master, Britain, which enjoys the world’s oldest democracy—US$52,000 versus US$37,000, according to the World Bank, based on purchasing power parity In another example, Russia grew faster under Putin’s more-authoritarian rule during the 2000s, compared with the 1990s when Russia was presumably more democratic under Yeltsin In contrast, the economies of most established democracies have been stagnant or declining—the Great Recession of 2008–2009 can serve as Exhibit A here Many Westerners have been tremendously disillusioned by their governments’ actions

to use taxpayer dollars, euros, and pounds to bail out banks—without much democratic consultation with the taxpayers.

Many Chinese willingly put up with the dictatorship that erns China if the regime delivers jobs, wealth, and economic growth

gov-Of course, they do not have a choice anyway But tellingly, the 2013 Pew Survey of Global Attitudes found that 85% of Chinese were “very satisfied” with their country’s direction, compared with only 31% of Americans, 30% of British, and 20% of Japanese Some Chinese elites argue that their model is more efficient than democracy in delivering growth Just witness the new skyscrapers, highways, and airports that are thrown up in an amazingly short period of time In two years, China implemented pension coverage to an additional 240 million rural residents—a process that would take decades in a democracy